Lender-Borrower Relationships and Loan Origination Costs

37 Pages Posted: 25 Apr 2017

Multiple version iconThere are 2 versions of this paper

Date Written: January 2017

Abstract

Using a recently developed method of causal inference, this paper estimates the additional up-front loan origination costs that a small business can expect to pay when it first borrows from a new lender. I compare firms that borrow from a previously unused financial institution with firms that borrow from a financial institution with which they have a preexisting financial relationship. I estimate that firms that borrow from a new financial institution can expect to pay $5,650 to $6,980 more in closing costs than firms that return to a previously-used financial institution. Based on these findings, I argue that a central function of origination fees is to pay for the production of detailed, firm-specific information that is valuable to the lender. I study a natural quasi-experiment wherein, for a small group of firms, selection into borrowing from a new lender is close to random. Returning to the wider population of small business borrowers, I use the method of Altonji, Elder, and Taber (2002, 2005) to account for endogeneity in firms’ selection to borrow from a new lender. The method of Altoji, Elder, and Taber allows me to measure the degree to which a firm’s selection to borrow from a new lender is driven by unobservables that also determine closing costs and to correct for any resulting bias. All analyses confirm that borrowing from a new financial institution causes firms to pay higher loan origination costs.

Keywords: Small Business Finance, Small Business Lending, Small Business Loans, Lending Relationships, Loan Contracts, Debt Contracts, Switching Costs, Information Costs, Causal Inference, Quasi-Experiment

JEL Classification: G20, G21, G32, L26, C31

Suggested Citation

Ostromogolsky, Philip, Lender-Borrower Relationships and Loan Origination Costs (January 2017). FDIC Center for Financial Research Paper No. 2017-03, Available at SSRN: https://ssrn.com/abstract=2957600 or http://dx.doi.org/10.2139/ssrn.2957600

Philip Ostromogolsky (Contact Author)

Federal Deposit Insurance Corporation ( email )

550 17th Street NW
Washington, DC 20429
United States
202-898-6585 (Phone)

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